There are all kinds of theories and wives tales people use to predict the outcome of presidential elections. Some say it’s by the number of candidate masks sold at Halloween. Others swear by which cup – a red or blue one – 7-Eleven sells more of during an election season.
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Then there are those who rely on the stock market.
The 2015 Stock Trader’s Almanac warns investors that presidential elections have “a profound impact on the economy and the stock market.” It cites wars, recessions, and bear markets that have historically tended to begin in the first half of a new president’s term, while more prosperous market events and bull markets tend to result in the back half.
Jeffrey Hirsch, editor of the almanac, said the reason for the trend is new and second-term administrations trying to do their best to maintain power.
“Some are more effective than others with more favorable policy initiatives. During the first year, a new president slams policy across, like President Obama did with Obamacare. It’s not just party versus party, though, but an incumbent trying to maintain power, in some cases,” Hirsch said.
Data from S&P Capital IQ shows the S&P 500 tends to perform better under Democratic presidents than Republicans. On average, for every year since 1945, the index has gained 9.7% under Democrats, and 6.7% under Republican administrations.
Sam Stovall, managing director of U.S. equity strategy at S&P Capital IQ, said the market performance is mostly due to the message the candidates send to the American people.
“Democrats say ‘it’s because we’re the party of the people. We can do things that stimulate economic growth.’ Republicans say, ‘Yea, you’re the part of tax and spend, and spend, and spend. And that’s why traditionally the market goes up, because we’re the ones who have to clean up the mess,’” he explained.
Stovall said that’s likely the reason why there’s been a recession in the first two years of every Republican administration since President Warren Harding, who served from 1921-1923.
“As a result, we see Nixon’s compound growth was -5.1% because he had to endure the near 5% mega meltdown in 1972-2973, and Bush was saddled with two mega meltdowns. He inherited the tech bubble bursting in 2001-2002, and the obviously he was there for the housing and financial collapse from 2007-2009,” Stovall said.
But forget about individual presidencies for a moment: There’s more to a federal government than the individual who leads from the Oval Office.
When looking even more granularly, you find stock markets respond best when a president and both chambers of Congress are from the same party. For 28 years since 1944 when the government has been unified, the S&P 500 has averaged 10.9% annualized gains. And the index’s performance slides as the government gets less and less unified. Under a unified Congress with a president of the opposite party, for 31 years since 1944 the S&P has averaged 7.6% gains, and under a split Congress, the index has risen 6.9%.
Stovall argued that while presidential administrations and Congress play a significant role in setting the nation’s policy, sometimes they get lucky with how the market reacts and performs under any one administration. In other words, it’s not always purely policy decisions that drive the market.
“Just as performance under Ford looks so good because he was coming out a bear market, I think that’s what contributed to the 13.6% split return under Democrats with Obama,” Stovall said. “Nothing really got done, but the market advanced on its own accord because we were down 57%.”
He said more likely market action has to do with the Federal Reserve rather than the president and Congress (with a couple of exceptions like the fiscal cliff and the debt ceiling debates).
“You could say that the Fed is what caused the problems for Bush 43 because with the Fed keeping rates so low, it ended up inflating housing prices and leading to the collapse…was that really Bush’s fault? Probably not. It had more to do with Greenspan than anything. Did Obama really stimulate economic growth to get to 13.6%? Absolutely not. It was Bernanke’s helicopter policy that ensured we would not repeat mistakes from the 1930’s,” he concluded.
Sector by Sector, Gain by Gain
So how can you play the market in an election year? It gets a little more complicated, but Stovall said there are some sectors of the market you can watch as the election-year drama unfolds.
“There’s not traditionally one sector that does better during election years….but you can listen to the issues of the candidates and decipher whether the platforms they embrace would be helpful or hurtful of industries or sectors, and then monitor those,” he suggested.
Recall last month when Democratic frontrunner Hillary Clinton tweeted that if she were to be elected to the White House, she would crack down on sharp drug-price increases. The move helped fuel a plunge in biotechnology stocks – hitting several individual names like Valeant (NYSE:VRX), pretty hard.
In that case, an investor could keep a close eye on biotechs since Clinton would likely to try to create price-setting policy.
But, in this election cycle, Stovall warned biotech and health-care names could be hit no matter which party assumes office.
“I think in general health care is going to be a lightning rod for both parties because whoever the Republican candidate is, they want to undo Obamacare. That would throw turmoil into all of the health-care sector, while Hillary Clinton would throw biotechs and pharma into a tailspin,” he speculated.
Historically, Stovall said defense stocks tend to perform better under Republicans, especially if their platform is to undo sequestion and increase the budget for the Defense Department. Energy names also tend to outperform because the party is less demanding when it comes to restrictions on energy and clean-air policies.
In the end, he said the political story and the trends behind it are fun to watch, but what happens at the Federal Reserve behind the political scenes is real to the markets. So, investors, he suggested, should keep an eye on inflation and earnings in the year ahead, saying a flat to inverted yield curve is likely an indicator of an impending recession and bear market.